Corporate Philanthropy Inspires Trust: Does It Also Prompt Higher Profits?Published: January 10, 2007 in Knowledge@Wharton
Your mother probably told you that it pays to be nice, but that may not necessarily be true when it comes to corporate philanthropy.
Wharton finance professor Vinay B. Nair and Columbia University's Raymond Fisman and Geoffrey Heal looked at whether being charitable -- such as donating money to medical research or to organizations that promote economic self-sufficiency -- helps a company's financial picture. They concluded that it all depends on the type of industry.
"Corporate philanthropy and profits are positively related only in industries with high advertising intensity and high competition," the researchers say, citing as examples the beverage and retail industries. In low-advertising industries, such as computer chips and business-to-business services -- "there is actually a negative association between philanthropy and profits."
The mixed-bag findings come at a time when more and more companies are putting on a generous, good-citizen face. "In the business community, corporate social responsibility (CSR) has emerged as a significant theme," Nair writes in a paper titled, "A Model for Corporate Philanthropy," co-authored with Columbia Business School professors Raymond Fisman and Geoffrey Heal.
They cite a survey last year by the Economist on corporate giving. Of the 135 executives and 65 investors who responded, 85% said corporate social responsibility was a "central" or "important" consideration in investment decisions. That figure was almost double the 44% who responded similarly five years before.
"Doing well by doing good" has become a familiar motto in the business community, which acknowledges that the motivation to "do good" is at least partly self-serving. It is thought that consumers may prefer to "purchase products from companies with high ethical standards," Nair and his team write. If that is true, then "companies may increase profits by acting as upstanding corporate citizens."
In some cases, companies may be able to deliver a "warm glow" to customers, making them feel good about giving business to a company that seems to act responsibly in producing its products. Buying fair trade coffee, for instance, might give caffeine lovers a sense of global connectedness as they fuel their daily habit. Likewise, "Made in the USA" labels may alert customers that a garment company used no Third World sweatshop labor in turning out the latest fashion trends.
The pink-ribbon phenomenon that is all the rage these days is one of the latest twists in corporate philanthropy. Customers can indirectly donate money to breast cancer research or breast cancer awareness campaigns by buying "pink products," such as Yoplait yogurt with pink lids or Campbell's soup with pink labels. There's even the "Crunch for the Cure" campaign, which raises the tantalizing possibility that eating junk food can be a kindly thing to do. Shoppers who buy a bag of specially-marked, pink-ribbon SunChips, for example, can go online and enter the bar code number to direct a 25-cent donation to the Susan G. Komen Breast Cancer Foundation. The Wall Street Journal reported recently that last year, "pink products accounted for $35 million of the Komen Foundation's $200 million in annual revenues."
But while corporate philanthropy sounds laudable, not everyone agrees that it's always a good idea. Economist Milton Friedman made the case that firms should simply lower their prices and let customers make their own charitable donations. Likewise, some people believe that "corporate giving is a waste of shareholders' money," Nair says. Shareholders may not agree with how company officials decide to direct the firm's charitable giving, and they may, like the individual consumer, simply prefer to get a bigger dividend check and spend it on charities or products of their own choosing.
The Trust Factor
But Nair and his colleagues theorize in the paper that charitable giving may be good for the bottom line because it helps to convince consumers that a company and its products are trustworthy. Trust factors into many purchases, particularly when it is not obvious why one product is better than another. Nair uses the example of "natural food" products, which typically are priced higher than standard items even though they may not taste any better. Natural foods are a rapidly growing business.
"Consider, for example, the task faced by a consumer in deciding whether to buy 'natural' beef from Whole Foods Market," the researchers suggest in their paper. "Given that it is difficult, even after consuming the product, to verify the absence of bovine growth hormones, it is essential that Whole Foods establish its trustworthiness in the eyes of its customers.... While there are consumer watchdogs and legal obligations that ameliorate such concerns to some degree, the purchase ultimately involves a leap of faith that the company is not passing off cheap, factory-farmed beef as a premium product."
Applying the same argument to the broader marketplace, the researchers make a case for why corporate philanthropy is more likely in industries characterized by high advertising -- "where a firm's image is important to consumers" -- and in industries where "firms are closer together in [their] products." Visible corporate philanthropy provides a "source of product differentiation in an otherwise uniform market space," the researchers say.
But what about making money?
To gauge the relationship between corporate giving and profits, the researchers collected financial data from 1991 to 2003 on 3,000 companies from the Compustat database. They also turned to a corporate database maintained by KLD Research & Analytics that focuses on "social actions."
Companies were assigned a philanthropy rating score based on certain levels and patterns of giving, such as support for housing or education initiatives. The researchers excluded from consideration good deeds that could also have the effect of boosting a company's productivity and, in turn, its profits. For instance, a company's decision to operate an environmentally friendly plant could increase efficiency. Likewise, a company that offers flex time and good maternity leave benefits may reap the benefits of a more loyal and productive workforce.
The researchers found, as they suspected, that there was much more philanthropy going on in advertising-intensive industries. "The advertising-intensive industries (the top 25%) have average KLD philanthropy ratings that are more than double those in the bottom 25% of advertising intensiveness."
But when it came to profitability, being generous paid off -- or at least didn't cause a financial drag -- only under certain circumstances. "In advertising-intensive industries, there is a more positive relationship between philanthropy and profit," the researchers concluded. "In an industry with very low advertising expenditures," such as the steel industry, "there is actually a negative association between philanthropy and profits."
From the perspective of competition, "for competitive industries, the direct cost of giving is offset by the benefits of differentiation" that flow from corporate philanthropy, the researchers write. Corporate philanthropy isn't necessarily making those companies rich, but it isn't hurting their bottom line, either. "Corporate philanthropy may act as a signaling device, indicating that a firm's products are reliable and that it can be trusted to provide high quality in those dimensions where the consumer cannot readily check quality before buying," the paper concludes.
Companies may also "use philanthropy as a signal of the quality of their products and their concern for the consumer." Finally, "corporate philanthropy should be more common in industries where products are less differentiated," such as the oil industry, the researchers say.
Nair notes that his team's findings are the "first evidence that corporate philanthropy can have both a positive and negative impact on profits depending on what industry you're in. If you're in the top 10 percentile for advertising-intensive industries, then corporate charity does not appear to be harmful to profits."
According to Nair, building trust with customers is a big issue for companies these days because of high-profile corporate scandals such as Enron and others. "People in general don't have too much faith in corporations; that is becoming clearer and clearer," he says, adding that the results of the study don't mean he's making a case against corporate generosity. But he suggests that it's important for companies to understand the motivations and implications of their charitable acts.
The paper's conclusions, he suggests, could be used to help shape a company's advertising message. "If what's driving customers is trust, then advertising should take a different form," he says. "Rather than just tying ribbons, you should advertise the fact that you are a good corporate citizen."